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Last month, the Federal Reserve announced a third major quantitative-easing initiative, committing to open-ended purchases of mortgage bonds and effectively guaranteeing three more years of near-zero short-term rates. That's good news for borrowers, and, by design, not great news for income investors. Income-oriented investors have already plowed into higher-risk bonds in their search for yield, bidding up prices and driving down yields—a trend that keeps getting worse. Fixed-income is also made more precarious with the looming fiscal cliff threatening an already-fragile economy. And then there's the endless decoding of economic indicators, divining the Fed's target rates for employment and inflation, and parsing what constitutes an acceptable level of economic growth to allow an end to central-bank intervention.

All this makes it increasingly hard to ride entire asset classes higher, and indicates a shift toward smaller-scale security selection. Barron's canvassed the industry's top fixed-income managers to see how they're investing in this particularly tough landscape.

Rieder joins the consensus in expecting 10-year Treasury yields to inch up toward 2% in the last months of 2012, and not expecting them to fall much below 1.6% during that time (the 10-year Treasury's current yield is 1.64%). From an investing perspective, Rieder likes the three- to six-year part of the Treasury yield curve, which offers more yield than shorter Treasuries while still falling largely within the Fed's low-rate time frame.

The Fed aims to ignite growth by boosting housing and, ultimately, employment. But David Glocke, head of Treasury-bond trading for Vanguard, is skeptical. "I really just don't see QE3 having a significant positive benefit on economic conditions," Glocke says. "The majority of the effect will be seen in higher commodity prices -- food, fuel, etc. -- and I'm more concerned about inflation."

With the Fed effectively pinning down short-term rates, yields on longer-term Treasuries are more likely to rise in response to inflation concerns, particularly as the Fed winds down its Operation Twist program of purchasing longer-dated Treasuries. As a result, Glocke expects a gradual steepening of the yield curve, meaning longer-term Treasury yields rising more than short-term ones.

Dan Fuss, manager of the $22 billion
Loomis Sayles Bond Fund
(LSBRX), says the key numbers currently being bandied about are 3%, the market's estimate of the Fed's target rate for inflation, and 7%, the estimate for the Fed's target rate for unemployment. "I think it's reasonably accurate, and the focus is on the 7% figure," Fuss says. That's because monitoring the employment number might provide the best hint as to when the Fed deems the economy healthy enough to try to stand on its own. Employment requires growth (and vice versa), and when unemployment starts to approach that 7% figure (it's currently at 7.8%), it should be accompanied by gains in growth, which should augur a broader switch from bonds into stocks and other riskier assets.

WHILE THE EMPLOYMENT FIGURE might be driving the Fed, the inflation number is what most worries bond investors. Paltry bond yields provide negligible protection against an eventual uptick in inflation and rates, and offer little income in the interim. As investors have scoured the market for yield, they've bid up riskier securities, such as high-yield corporate bonds or certain mortgage-backed securities, to lofty levels.

"One of our core themes is to take in yield and income as aggressively as possible," says Rieder, pointing particularly at high-yield bonds. "I think there's room to go further, but I see more of a transition to opportunistic investing." That opportunism can mean wading into some pretty risky waters. Rieder says sovereign and bank bonds of Italy -- yes, Italy -- could start looking attractive if the European financial crisis finally stabilizes for real. He also sees opportunities in Asia.

Domestically, several of these managers are investing more in nonagency mortgage-backed securities, which lack government backing but could see residual benefits from the Fed's mortgage-bond purchases. Agency mortgage bonds -- those backed by Fannie Mae and Freddie Mac, which are the targets of the Fed's buying under QE3 -- are already overpriced.

"You have to own the things that make the most fundamental sense," says Ken Taubes, chief U.S. investment officer at Pioneer Investment Management, who says corporate bonds, high-yield in particular, are still a good investment, even at somewhat elevated prices. "What you're really looking at is collecting your income, which is still better than earning close to zero in a Treasury bond."

Fuss sees another two or three years of investors chasing after the same higher-yielding asset classes, bringing down spreads and yields for everybody. "You want to start to substitute specific risk for market risk, [which means] being a bond picker," Fuss says. "This is such a shopped-over market that if you do find something, you want to keep your mouth shut and buy as much as you can."